CAPTIVE 101

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CAPTIVE 101

• From a, Legal, Regulatory, Actuarial and Taxation
  Perspective

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Speakers

• Speakers
• Neil, Horner, Partner and Head of Corporate,
  Attride-Stirling Woloniecki
• Scott Slater, Tax Manager, PWC
• Darren Ma, Actuary, PWC
• Leslie Robinson, Assistant Director, Insurance
  Licensing Authorization, Bermuda Monetary
  Authority
• Moderator
• Beverley Todd, Executive Vice President, JLT
  Insurance Management

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Bermuda Captive 101 A legal primer

• Why form a captive in Bermuda

• Prudent and flexible regulation
• Speed to market
• Access to the Bermuda reinsurance market
• World class infrastructure
• Pre-eminent captive domicile
• Excellent judicial system
• Intellectual capital

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Bermuda Captive 101 A legal primer

• The Path to Licensing
• Select service provider team
• Apply to incorporate the company
• Apply to licence the company
• Incorporate, organise and capitalise
• Registration as an insurer/reinsurer

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Bermuda Captive 101 A legal primer

• Choosing the team
• Insurance manager to manage the captive and
  principal representative
• Auditors
• Lawyers and corporate administrators
• Actuary if required

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Bermuda Captive 101 A legal primer

• Captive formation
• Captive formation involves incorporation of a
  company under the Companies Act 1981 and
  registration under the Insurance Act 1978
• Quite distinct processes possible to run both
  simultaneously or apply to incorporate ahead of
  licensing application

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Bermuda Captive 101 A legal primer

• Incorporation
• Application to incorporate company made on
  specific application form to Registrar of
  Companies and Bermuda Monetary Authority (BMA)
  Controller of Foreign Exchange
• Details of proposed ownership structure in
  captive must be disclosed right through to
  ultimate beneficial owners
• BMA vets shareholders to make sure they are fit
  and proper persons - must also be approved as
  shareholder controllers of insurance company
• Individuals owning more than 5 of voting equity
  of captive must also complete a personal
  declaration form
• Though we do not have off the shelf
  incorporations, incorporation process is very
  streamlined and can have same day approval

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Bermuda Captive 101 A legal primer

• Insurance application

• Application to register as an insurer must be
  made to the BMA Insurance Division
• Application made on a Monday of each week and
  considered at the weekly Friday meeting of the
  Assessment and Licensing Committee (ALC) of the
  BMA
• ALC may call upon assistance of Technical
  Advisory Group (TAG) composed of industry
  representatives in all classes except pure
  captive (Class 1 applications)
• ALC/TAG may approve the application with or
  without conditions, approve it conditional upon
  production of certain information, defer it or
  decline it if business case cannot be
  substantiated

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Bermuda Captive 101 A legal primer
Mechanics of insurance application

• Application will have cover letter from the
  captives attorneys together with the business
  plan for the captive setting out the business
  case for the captive
• Pre-incorporation form must be completed
• Proforma financials should be included preferably
  over 5 year period and ideally actuarially
  evaluated to test adequacy of reserves, solvency
  margins and liquidity ratios
• Details of service providers should also be
  included (insurance manager, auditor, loss
  reserve specialist and principal representative

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Bermuda Captive 101 A legal primer

• Business Plan
• Details of Shareholder
• Proposed insurance program
• Capitalisation of the company
• Directors
• Service Providers
• Reinsurance arrangements

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Bermuda Captive 101 A legal primer

• Steps to insurance registration
• Incorporation
• Organisation of company
• Hold board and shareholder meetings to
• issue shares
• adopt bye-laws
• appoint auditors and insurance manager
• Capitalise captive
• Amount of capital will depend on class of insurer

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Bermuda Captive 101 A legal primer

• Application for insurance registration
• File formal application with the BMA
• Formal application is on form 1B- will be
  identical to pre-incorporation form
• Formal registration can be the date consent is
  received or as the shareholder wishes
• Company can then write business

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Bermuda Captive 101 A Tax Perspective

• Agenda
• Introduction
• US Tax Benefits to forming a Captive
• US Taxation of a Captive
• Summary

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Bermuda Captive 101 A Tax Perspective

• Insurance - Understanding the U.S. Tax
  BenefitsCaptive versus Self Funding
• FAS 5 Standard for accruing liabilities
• Estimable and Probable Standard
• US Tax Standard for deducting accrued liabilities
  under IRC 461 Economic Performance Standard
• Liability must be fixed and determinable
• Economic performance occurs within 8 ½ months
  (i.e., payment) restrict deductibility to cash
  method
• US Insurance Company Taxation (Subchapter L)
• May establish (i.e., deduct) a reserve which is
  fair and reasonable
• May earn certain revenues over period of
  obligation (e.g., Extended Service Contracts)

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Bermuda Captive 101 A Tax Perspective

• Insurance - Understanding the U.S. Tax
  BenefitsCaptive versus Self Funding
• In a consolidated group, the federal income tax
  benefit of a captive is not deductibility of
  premium, it is the ability to establish
  deductible loss reserves
• Achieve Tax/GAAP parity
• Special Treatment for Small Insurance Companies
• IRC 501(c) Tax Exempt
• Gross Receipts lt 600,000 on a controlled group
  basis
• gt50 GR must be insurance premiums
• IRC 831(b) Election
• Taxed only on investment income Premium levels
  350,001 to 1.2M
• Estate and Wealth Transfer Benefits

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Bermuda Captive 101 A Tax Perspective

• Definition of Insurance What is insurance for
  U.S. tax purposes?
• Neither the Internal Revenue Code nor the
  Treasury Regulations define the term insurance
  or insurance contract.
• In 1941, the Supreme Court in LeGierse determined
  insurance did not exist where two linked
  insurance contracts failed to shift risk of loss
  away from insured. Established requisite
  components of insurance
• Presence of insurance risk
• Required risk shifting and risk distribution
• Insurance was found in its commonly accepted
  sense
• A number of Rulings and cases have defined these
  components over time.

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Bermuda Captive 101 A Tax Perspective

• Entity Level Taxation IRC 953(d) Election
• (D Company) - Election to be treated as a US
  domestic insurance company taxed on worldwide
  income
• Requirements of the d election
• Must be insurance company (would be subject to
  tax under Subchapter L)
• 25 or more shares owned by U.S. persons
• Revenue Procedure 2003-47 (guidance/steps for
  making the election)
• US Office and Assets
• Assets of affiliate (if filing consolidated
  return)
• Unencumbered US assets
• Letter of Credit
• Election specifics
• Due by filing of first US tax return (typically
  3/15 unless extended to 9/15)
• Election irrevocable without consent
• Cannot re-elect for five years

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Bermuda Captive 101 A Tax Perspective

• Entity Level Taxation IRC 953(d) Election
  Advantages
• Exemption from the US federal excise tax on
  premiums paid to a foreign insurance company
• Exemption from the withholding tax imposed on
  certain types of fixed and periodic (FDAP)
  income from US sources
• Exemption from the branch profits tax imposed
  on certain earnings of foreign corporations that
  are engaged in a US trade or business
• Ability to hold meetings and conduct business
  activities within the US
• Does not alleviate state regulatory concerns
• Ability to join in filing a consolidated US
  federal income tax return (if applicable)
• Ability to more freely invest in US property
• Ability of US shareholders to enjoy the benefit
  of the dividends-received deduction

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Bermuda Captive 101 A Tax Perspective

• Entity Level Taxation IRC 953(d) Election
  Disadvantages
• Potential for double taxation on distributions
  made to shareholders
• Mandatory change of the companys tax year end to
  December 31 or the year end of the parent company
  in consolidation
• Subject to current taxation on worldwide income
  with no treaty benefits available
• Subject to Dual Consolidated Loss Rules

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Bermuda Captive 101 A Tax Perspective

• Entity Level Taxation IRC 953(d) Election
• 953(d) Company US tax filings
• Form 1120-PC annual
• Form TD F 90-22.1 annual if own foreign bank
  accounts
• Estimated Tax Payments - quarterly
• Audit/Accounting issues
• Requires tax accrual at the entity level

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Bermuda Captive 101 A Tax Perspective

• Entity Level Taxation IRC 953(c)(3)(C)
• (C Company) - Foreign insurance company may
  elect to treat RPII as effectively connected
  income
• Requirements
• Must be insurance company (would be subject to
  tax under Subchapter L)
• Must be a CFC (25 or more shares owned by U.S.
  persons)
• Election irrevocable without consent
• Revenue Procedure 2003-47
• Guidance/steps for making the election
• VERY RARE

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Bermuda Captive 101 A Tax Perspective

• Shareholder Level Taxation CFC
• U.S. has no authority to tax foreign corporations
  not engaged in a U.S. trade or business
• Controlled Foreign Corporation or CFC Rules
  (1962)
• Two tier test
• US Shareholder defined
• 10 or more voting stock
• Collectively owning gt50 vote or value
• For Insurance Income special gt25 Rule
• Deemed distribution provisions
• Insurance income
• Foreign personal holding company income
• Interest, dividends, capital gains, etc.
• Audit/Accounting issues
• Generally no tax accrual at the CFC level
• FIN 48 Determination if a US trade or business

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Bermuda Captive 101 A Tax Perspective

• Shareholder Level Taxation RPII CFC
• Related Person Insurance Income, or RPII Rules
  (1986)
• Defined as insuring the US persons who control or
  is controlled by the insurer
• Required RPII / Non-RPII split of management
  accounts
• Any Shareholder replaces 10 voting shareholder
  for these purposes
• 25 or more replaces the gt25 ownership test
• De minimus exception
• Less than 20 RPII
• Less than 20 vote value held by related persons
• Audit/Accounting issues
• Generally no tax accrual at the RPII CFC level
• FIN 48 Determination if a US trade or business

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Bermuda Captive 101 A Tax Perspective

• Shareholder Level Taxation US tax compliance
• U.S. Shareholder
• Form 5471
• Category 3
• Certain contributions situational
• If RPII CFC - annual
• Category 5 if Captive is a CFC annual
• Inclusion of Subpart F income
• Form 926 - situational
• Certain contributions
• U.S. Officers and Directors
• Form 5471 - situational
• Category 2 Acquisitions of 10 or more by a
  U.S. shareholder
• Insureds
• Form 720 - quarterly
• excise tax on US risk to foreign insurer
• Captive
• protective return (optional) - annual

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Bermuda Captive 101 A Tax Perspective
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Bermuda Captive 101 A Tax Perspective

• Gross Level Taxation US Federal Excise Tax
• Federal Excise Tax IRC 4371- 4373
• 4 on direct premiums
• 1 on life, annuity, health, and reinsurance
• Assessed on premiums paid
• Any party to the transaction is liable for the
  tax
• Cascading theory
• Treaty benefit based on residence of (re)insurer
• Rev Rul 2008-15
• US Corp insures risk with treaty-exempt Foreign
  Insurer.
• Foreign Insurer reinsures with non-treaty
  exempt Foreign Insurer.
• Conduit Agreement FET on both transactions
• No conduit agreement FET on reinsurance
  transaction
• Potential impact on captives
• Enforcement issues??
• Not a FIN 48 Issue FAS 5

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Bermuda Captive 101 An Actuarial Perspective

• Agenda
• Setting up Captive
• Captive Feasibility Help
• Type of Captive
• Reasons for Captive
• Capital Strain
• Other Considerations
• Captive Pricing Trends

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Bermuda Captive 101 An Actuarial Perspective

• Captive Feasibility Help
• Quantify costs associated with Companys proposed
  program. (Premium)
• Reinsurance Optimisation (Net Retention)
• Project Liabilities (Reserves)

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Bermuda Captive 101 An Actuarial Perspective
Captive Feasibility Help

• Business forecast projection at various
  confidence levels
• What plans are there for the captive i.e.
  staggered implementation
• What are the potential risks e.g. unexpected
  losses, volatility shocks
• Pricing / funding / initial reserves of the
  captive
• Setting economic capital vs statutory capital

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Bermuda Captive 101 An Actuarial Perspective

• Type of Captive
• Pure Captive
• Own prior experience
• Future expectations
• Association Captive / Risk Retention Group
• Pooled Experience
• Agency / Rental / Sponsored Captive (Segregated
  Cell)
• Pooled Solvency

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Bermuda Captive 101 An Actuarial Perspective

• Reasons for Captive
• Cost Stability
• Less Cyclical Pricing
• Access to Reinsurance
• Better Internal Control
• Improved Cashflow

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Bermuda Captive 101 An Actuarial Perspective

• Capital Strain
• May need more comprehensive reinsurance to start
• Retain larger limits and add more risk as capital
  builds
• Realistic growth projections
• Careful claims management

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Bermuda Captive 101 An Actuarial Perspective

• Captive Pricing Trends
• Commercial Property Market Still Soft
• WC Price Declines but Medical Costs Up
• Professional Liability High Surplus and
  Declining Premium
• Medical Malpractice Frequency Stable but Loss
  Costs Up

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Bermudas Captive Regulation

• Agenda
• Legislation
• Other Guidance
• Class Structure
• Ratios Margins
• Statutory Financial Return
• Supervisory Model Risk-Based Framework
• Regulatory Approach
• International Initiatives

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Bermudas Captive Regulation

• Insurance Act 1978
• Insurance Accounts Regulations 1980
• Insurance Returns Solvency Regulations 1980
• Non-Resident Insurance Undertaking Act 1967
• Segregated Accounts Companies Act 2000

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Bermudas Captive Regulation

• Guidance Notes
• 20 separate Guidance Notes issued to date
• Role of service providers
• Market Conduct
• Corporate Governance
• Risk Management and Internal Controls
• Investment Activity
• Investments in Affiliates
• Enhanced Capital
• Special Purpose Insurers

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Bermudas Captive Regulation

• Code of Conduct
• Establishes duties, requirements and standards to
  be complied with by insurers including the
  procedures and sound principles to be observed
• Application will take into account the insurers
  nature, scale and complexity
• Captive insurers should be mindful of the
  proportionality principle in establishing a sound
  corporate governance, risk management and
  internal controls framework.

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Bermudas Captive Regulation
Classes of General Insurance

• Class 1 - Pure Captives
• Class 2 - Group / Association Captives
• Captives writing less than 20 unrelated business
• Class 3 - Captives writing up to 50 unrelated
  business
• Class 3A - Small Commercial Insurers
• Class 3B - Large Commercial Insurers
• Class 4 - Property Catastrophe / Excess
  Liability

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Bermudas Captive Regulation
Other Classes of Insurance

• Long-Term Insurers - Insurer writing long-term
  business (annuity or life, some accident and
  health business)
• Special Purposes Insurers - Insurer fully funds
  its liabilities to the persons insured through a
  debit issuance or some other approved financing
  mechanism cash or time deposits.

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Bermudas Captive Regulation
Minimum Solvency Margin requirements
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Bermudas Captive Regulation
Statutory Financial Return

• Cover Sheet
• Declaration of Statutory Ratios
• Solvency Certificate
• Auditors Report
• Loss Reserve Specialist Opinion
• Class 1 Only required if discounting
  reserves to meet solvency margin or more than
  30 of the business written is professional
  liability
• Class 2 Triennially (unless discounting
  reserves to meet solvency margin, or more than
  30 of the business written is professional
  liability)
• Class 3 Annually

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Bermudas Captive Regulation

• Captive vs. Commercial
• Risk-Based Approach
• Role of Principal Representative and Insurance
  Manager
• Captive Manager On-sites
• Segregated Accounts Companies (Rent-a-Captives).

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Bermudas Captive Regulation

• Pragmatic Approach to Regulation
• The Worlds Risk Capital
• Creativity and Innovation
• Section 56 Directions
• Modifying accounting regulations
• Approving relevant assets
• Admitting assets
• Modifying filing requirements
• Regulations consistent with International
  Standards but applied appropriately for Bermuda
  Market.

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Bermudas Captive Regulation

• International Initiatives
• Monitoring and Actively Contributing to
  International Regulatory Developments
• International Association of Insurance
  Supervisors (IAIS)
• Member of IAIS Executive Committee
• Chair the Reinsurance Transparency Group
• Authority staff are on a total of 13 IAIS
  Committees
• Solvency II
• Capital Adequacy, Group Supervision, Disclosure
  Transparency
• Bermuda seeking Solvency II equivalence
• We believe our captive regime is already in
  accordance with international standards, however,
  we continue to monitor any global developments
  relevant to captives and we will adjust our
  regime accordingly.

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Bermudas Captive Regulation
WWW.BMA.BM
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Bermuda Captive 101

• Questions?
• Beverley Todd, Executive Vice President, JLT
  Insurance Management (Bermuda) Ltd.
• Neil Horner, Partner and Head of Corporate,
  Attride-Stirling Woloniecki
• Scott Slater, Tax Manager, PWC
• Darren Ma, Actuary, PWC
• Leslie Robinson, Assistant Director, Insurance
  Licensing Authorization, Bermuda Monetary
  Authority